ChristopherCarrollSmith

Equity sentiment suddenly got very bearish this week

INDEX:CPCE   None
Sentiment Is Suddenly Very Bearish on Equities, SPX , NDX, RUT

It's been a volatile few weeks of trading as the S&P 500 pulled back a bit (and the Nasdaq pulled back a bit more). Bearish sentiment has grown as the price dipped. The $CPCE equity put/call ratio rose sharply this week to levels last seen in March 2020, near the beginning of the pandemic.

The current put/call ratio on the $SPY S&P 500 ETF is 1.5. That's actually better than the average for the last 30 days (1.7), but it's still quite negative. Sentiment is even more negative on the $QQQ Nasdaq ETF , with a put/call ratio of 2.2. The $IWM Russell 2000 small cap ETF is looking even worse, at 2.3. Stock market options traders seem to think that interest rates will continue to rise and the stock market bubble is soon to burst. A lot of the finance wonks I follow on Twitter sold into Friday's strength.


However, options on the $TLT 20+ year Treasury bond ETF are sending a different signal. With a put/call ratio of 0.9, bond wonks appear to expect at least a short-term weakening of rates and a rally in bonds from here. $TLT has entered a region of fairly strong technical support:


Despite Negative Sentiment, There Are Lots of Fundamental Reasons to Be Bullish

To be honest, I think the bearish sentiment in equities may be premature. We've got a fourth vaccine thanks to Johnson & Johnson , with Merck slated to help provide manufacturing capacity. This means we could get all US adults vaccinated 2 months earlier than expected. Plus Merck seems on the verge of getting approval for a Covid therapeutic that could be helpful as well. The savings rate rose during the pandemic, and a lot of that "quarantined cash" will be unleashed on markets as people get vaccinated.

Plus, there's more liquidity in the pipeline. We've got another round of $1400 stimulus checks coming. Markets have been worried about a federal minimum wage hike, but it doesn't look like that will happen. The stimulus bill provides $300 billion of support to state and city governments, which removes one of the big risks to the recovery: rising state and local taxes to cover budget shortfalls. Despite rising interest rates, private lending has ticked upward in recent weeks:


An uptick in private lending historically has been a confirmation signal that a recession has ended, as I laid out in a previous post:


Plus, the jobs numbers this week surpassed analyst expectations by a wide margin, and the ECRI leading economic index has resumed its upward trend. So economic data are signaling continued recovery ahead.

The Bear Case Is About Valuations and Rising Interest Rates

The bear case would seem to be threefold. First, valuations are very high. Which is absolutely true, but won't necessarily stop them from getting higher. Second, more stimulus means more inflation , which means interest rates could continue to rise. ( Inflation is bullish for stocks, but rising interest are bearish . So it's a tug of war between the two, and the question is whether rising interest rates will be enough to rein inflation in. The bears are betting that it will.) And third, there's a technical case for continued market weakness, because $SPY has violated its support trend line . However, I suspect it will establish a new, less steep support line a bit below the previous one. I suppose we could see a 10% correction to the 50-day EMA:


But even that feels unlikely to me, given the strength of the fundamentals. I think this correction could prove much more modest than that:


Admittedly, I'm not pouring cash into this market at these valuations. But despite rising bearish sentiment, I'm pulling cash out of the market, either. In my opinion, it's likely too early for that, given the fundamentals.
Comment: That second-to-last sentence should read, "But despite rising bearish sentiment, I'm *not* pulling cash out of the market, either." Cursed typos! *Shakes fist at the universe*
Comment: It looks like the market agreed with me that bearish sentiment was premature. Market is up quite strongly since I posted this.
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Comments

Thanks for sharing.
+2 Reply
Great analysis. That TLT chart caught my attention.
+1 Reply
@biotexbull, thanks!
Reply
I agree with you Christopher. The stock market still has strength despite the detracting factors at play.
+1 Reply
@Aidcon, thanks for commenting!
Reply
Chartguru1 ChristopherCarrollSmith
@ChristopherCarrollSmith, have to admit,I always have time to read your commentary and charting. Kudos! I do believe they want market lower nxt week and that lower low will create positive divergences. Just my 2 cents but I’m buying before March options expiry so not sure nxt week we rally hard. I’m waiting to buy in later in the week if I see a cratering. The put/call ratio approaching .9 is where I put money to work. Not there yet. Gd luck
+1 Reply
@Chartguru1, thank you!
Reply
Fantastic research. Thanks 👍
What do you think about growth stocks getting hit hard? Is there a sector rotation towards value stocks? Thanks.
+1 Reply
@SalviG, we have definitely been seeing rotation into both value and small caps. I called this rotation in its early days back in September and have continued to provide updates on it here:



If interest rates pull back a bit from here, then we'll likely see a short-term bounce in large cap growth. I would not be at all surprised to see Tesla, FAANG, and ARKK have a good week this week. Longer term, I think they will continue to underperform value and small caps for some time.
+2 Reply
SalviG ChristopherCarrollSmith
@ChristopherCarrollSmith, thanks for your fast reply ;)
Yes i remember your post.
Do you think it is a goof idea to continue investing in value and small caps from now on or keep liquidity and wait to see how the market will behave the next weeks?
The simple question is, will value stocks grew even with rising rates or will they get also hit?
+1 Reply
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